Should I Dollar-Cost Average Into The Market?

Dan Egan

Managing Director of Behavioral Finance & Investing

The correct answer depends on what most makes you comfortable with getting invested.

Originally published: January 29, 2013

KEY TAKEAWAYS

Odds are that dollar-cost averaging won't improve returns.

Indirect dollar-cost averaging as you get paid is ok though—your money goes into the market as soon as it can.

But if dollar-cost averaging makes you comfortable, it's better to do it than sit on cash.

First, let’s get some definitions out of the way. Dollar-cost averaging (DCA) refers to an investment strategy of investing a fixed amount of money over a time period (say 1 year). There are two types of DCA:

Voluntary DCA implies you have a liquid amount of cash to invest, but are intentionally parceling it out over time. The cash will (you hope) be earning interest while it’s not invested.

Involuntary DCA generally refers to auto-deposits set up to invest as you earn money. Your purchase points are at different points, but you did not have any period of sitting in cash.

The big difference between these two is how long you were sitting on cash, rather than investing it in a portfolio. Involuntary DCA implies that you could not have invested sooner, while voluntary DCA is an investment strategy where you could have, but chose not to.

Should I dollar-cost into the market?

Ok, gimme the answer already smartypants!

From a purely unemotional investment strategy perspective, because the expected total return of markets is positive, it makes sense to invest immediately, and not worry about timing the market. It’s important to remember that while the price of stocks may go up or down, they are usually paying about 2% in dividends. Thus your price return can be flat, but your total return (price return + dividend return) is still up. So if you wait, you’ll probably have a lower total return, though not by a large amount.

Sidenote: One valid investment strategy reason to practice dollar-cost averaging is because you have a weak view that the market will be going down in the near/short-term. Otherwise, it’s best to just invest the money, and not worry about timing it.

However, there are some very nice psychological benefits to dollar-cost averaging:

it diversifies your purchase price, which makes you less susceptible to the Disposition Effect

it likewise reduces your anxiety that you have bought “at the top”, and thus makes you less disposed to attempt market-timing and pull out after being invested.

it gives you a concrete plan for moving out of cash. The move from “safe” to “higher risk/return” is an uncomfortable one, and often people want to feel that they’re doing it in a controlled manner. Having a clear plan to do it over a period of time is better than not doing it at all.

With those points in mind, it actually can be more rational to voluntarily dollar-cost average. After all, it’s better to invest slower and more comfortably, than never invest at all.

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Dan Egan is the Director of Behavioral Finance and Investments at Betterment. He has spent his career using behavioral finance to help people make better financial and investment decisions. Dan is a published author of multiple publications related to behavioral economics. He lectures at New York University, London Business School, and the London School of Economics on the topic.
Contact Dan at Google+

4 thoughts on “Should I Dollar-Cost Average Into The Market?”

Great post and great work on behalf of the Betterment team! Regarding this topic, I fall into the “voluntary DCA” camp, having decided to invest a chunk of existing cash in 2013. While I thought I had a concrete plan to invest throughout the year (periodically after a 3-5% drops in the market), I never pulled the trigger at the start of January. As I watched the market go up and now that it’s at all-time highs, it seems even more daunting to start. Yes, I’m kicking myself for not committing Jan 1! Is this all psychological? Does it not really matter in the long-run? Any thoughts are much appreciated…

Indeed, the problem of actually “pulling the trigger” is the biggest hurdle to voluntary DCA being a good course for many investors. It is psychological (“now just doesn’t feel right”), and means that many individuals spend months, even years out of the market because they don’t ever feel comfortable moving in. This costs them exactly the risk premium they were looking to achieve.

An even more problematic (but behavioral) way of doing it is “buying on dips”. Rather than being agnostic about buying at the top (as DCA is), buying-on-dips ensures that you aren’t buying on the top, but rather into a fallen market. While it seems smart, most investors have a really hard time pulling the trigger when the markets are full of fear.

We’re currently debating offering these “getting invested” services. When you made a big deposit, you would have the choice of being invested (a) immediately, (b) DCA over 6-9 months, or (c) buy on dips. We’ll sort out all the details and execution, you just choose one which makes you comfortable.
Would you find those options helpful for getting invested in a systematic way?

Dan,
It’s great to see that Betterment’s listening to customers and coming up with new solutions. Options (b) and (c) above sound most interesting, since these are often “services” that many high-fee financial advisors offer. If there was a way to transfer funds to Betterment and have them parked in an MMA (or some other interest bearing account) while the DCA strategy plays out, that would be even better. Can’t wait to see what new features you and your team come up with!

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